Which is Worse for GDP: Spending Cuts or Tax Hikes?

Between spending cuts or tax hikes, which do you suppose does more damage to a nation’s economy?

If you said tax hikes, you’re right! Political Calculations recently looked at the impact of both government spending cuts in Greece, Spain and the United States, and found the following impacts for each dollar of either spending cuts or tax increases upon each nation’s GDP:

Here’s how to interpret the information in the chart. For each $100 of government spending cuts that were implemented, each nation’s GDP shrank by just $60. Meanwhile, for each $100 by each government expected that it would collect through tax increases imposed upon their most productive citizens, each of these governments actually shrank their GDP by $300. Almost needless to say, each of these three governments ended up collecting nowhere near what they expected to from their tax hikes.

So why does increasing taxes have such a large and negative impact, while cutting government spending has such a small impact by comparison?

Political Calculations explains:

Why do government spending cuts have so much less than a dollar-for-dollar impact? Perhaps the easiest explanation is that about 30-40% of all government spending is wasted in non-value added, non-productive activities that make no positive contribution to the nation’s gross domestic product.

Meanwhile, when the government hikes its taxes, it’s really acting to penalize the most productive people in the nation to support its wasteful spending activities. The multiplier is so large because tax hikes are so disruptive in their immediate negative effect upon the economy.

The amazing thing is that these impacts would appear to be so consistent from nation to nation, even though each has very different economies from one another, not to mention very different institutions and histories. And perhaps the strangest thing shared among all these nations is that the politicians in power who seek to implement tax hikes over spending cuts in trying to reduce their government’s budget deficits don’t appear to have learned the crucial lesson that they’re inflicting way more harm than good upon the people of their nations.

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